Basle II Accord :

Basle II Accord New Accord’s objective
Align regulatory requirements with economic principles of risk management
How?
Three Pillars which includes the measurement of Operational Risk.
Overall Goal
To provide a measurement for financial institutions to quantify their internal controls, the manner in which in they are managed and the level of regulatory capital that they must maintain.

Timelines :

Timelines First Consultation Paper June 1999
QIS 1 July 2000
Second Consultation Paper January 2001
QIS 2 April 2001
QIS 2.5 November 2001
QIS 3 (Technical guidance) October 2002
Third Consultation Paper July 2003
New Accord Mid 2004
Dual Running of old & new Thru 2006
Implementation of EU Directive End 2006

The Three Pillars :

The Three Pillars :

The Three Pillars Pillar II
Supervisory Review – Four Principles
Banks should have a strategy/process per institution for measuring their overall capital requirements and maintaining those capital levels
Supervisors should review and evaluate institution’s assessments and strategies for calculating capital requirements ( includes monitoring/compliance with regulatory requirements)
Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold more than the required capital level
Supervisors should be expected to intervene at an early stage should capital fall below specific levels

The Three Pillars :

The Three Pillars Pillar II
Accord Implementation Group (Aug 2003)
Set of principles to promote practical co-operation & information exchange among supervisors
To promote consistency through the exchange of information between supervisors on approaches to implementation.
Manage home-host implementation issues concerning the advanced approach to Operational Risk

The Three Pillars :

The Three Pillars Pillar III
Market discipline to ensure controls and soundness of banks
Core Disclosures, increasing transparency among banking institutions
No change since Basle 1

Effects of Basle II on Financial Institutions :

Effects of Basle II on Financial Institutions Effects
Implement strategy to align regulatory capital with economic risks
Choose the most appropriate credit/operational risk approach for your institution
Collect, store and analyse data across each function within your business
Embed these new or improved processes within your organisation

Challenges of Basle II on Financial Institutions :

Challenges of Basle II on Financial Institutions Understanding and interpreting the overall effects on each area within your business
Change management in relation to creating a risk aware culture in your organisation
Recognise the new expectations from regulators such as IFSRA, rating agencies and your customers
Review your current products as part of your business risk assessment
Outline a strategy to utilise any gains that may be achieved

Others :

Others Customers
New costs relating to disclosures, internal/external ratings/better collaterialisation
Ensuring transparency of transactions/processes
Regulators
New costs related to additional resources
Set incentives for banks through stress testing and review processes.
Rating Agencies
Provide an increased transparency with regard to rating components
Maintain a high quality of ratings
Increase competition with entry by other agencies within Europe to the market

Where to Start? :

Where to Start? QIS III analysis
350 Banks from 43 Countries participated
Main Result
Lack of data retained by each of the participating organisations

Getting Started :

Getting Started Senior Management Support
Identify and assign responsibilities at all levels
All ratings and estimations must be approved by the board of Directors or a designated committee
Senior management must have a good understanding of ratings systems designs and processes
Internal ratings must be an essential part of the reporting to these parties

Getting Started :

Getting Started Phase I
Supervisory Committee
Cross-functional
Identify other regulatory concerns that may overlap in relation to the corporate governance, such as Sarbannes Oxley and IAS.
Prepare a Gap Analysis
Prepare an Impact Analysis
Complete an overall risk assessment of your business
Complete a cost benefit related to the enhancements or new processes that need to be introduced to ensure compliant

Risk Database and Management Review :

Concerns :

Concerns LIBA & BBA August 2003
‘The new accord , as currently proposed , is unduly complex and will be difficult for our members to implement and for national regulators, even in the G10, to supervise’

Why implement? :

Why implement? The top ten banks in US are complying
Control 95% of all foreign capital held in the US
Using the AMA approach and Internal Ratings Approach
Along with other 10 banks control 66% of total US capital

Why Implement? :

Why Implement? Rating Agencies
Even with Basel II in mind, operational risk management should first and foremost be an effort to measure and control operational risk, rather than an exercise in efficient capital allocation’
‘Moody’s believe that well calibrated quantitative tools can effectively measure a large segment of operational risk, notably the high-frequency low impact events’
‘Many banks have begun in earnest to collect loss data and to build internal loss models’
‘A bank with good risk management systems is not necessarily a bank that will be invariably successful in avoiding risks. But good and reliable risk-management systems and processes are nevertheless a very good start.’

Data Management :

Data Management Technology
Based on your institutions requirements
May incorporate all three pillars in one
May involve a series of manual workarounds until system is developed

Data Management :

Data Management Requirement to segment the portfolio by;
Product Type
Borrower Risk
Delinquency Status
Vintage Analysis
The IRB methodology requires the calculation of ;
Probability of Default (PD)
The likelihood that a loan will default.
Exposure at Default (EAD)
Value of the gross Exposure. (ie. Balance outstanding + 75% of revolving credit facilities)
Loss Given Default (LGD)
The loss on a loan after the borrower has defaulted.

Data Management :

Data Management Credit Risk Gradings are required;
Minimum 6 to 9 grades for performing borrowers
Minimum 2 grades for non-performing borrowers
No more than 30% of gross exposures should fall in any single borrower grade
Credit risk is derived from the analysis of historical data.
Requirement to have five years of historical data for validation and calibration in models
Banks back test their models over an ‘economic cycle’
Stress testing every six months going forward
Models must be used in normal business decisions

Operational Risk :

Operational Risk Initially
May be manual reporting of events
Logging of risks
Technology
Could incorporate this into the overall credit risk system

Data Management :

Data Management Advanced Measurement Approaches
There are three potential approaches under Advanced Measurement
Models are based on a bank’s own internal rating systems and operational loss data
Internal Measurement Approach (IMA)
Business lines sub-divided by risk type
The models are generally based on the following information:
Operational Risk is a function of (EI * PE * LGE)
EI Exposure Indicator
PE Probability of Loss
LGE Loss Given Event

Data Management :

Data Management Loss Distribution Approach
Estimate future operational risk losses by each business line or risk type
Forecasting Models are required
Dependent on banks foreseeing the unforeseeable
3. Scorecard Approach
Scorecards are developed to rate the risk profile of each business line
COLLECTION OF OPERATIONAL LOSS DATA IS KEY
TO BUILDING INTERNAL RISK MODELS

Risk Of Not Implementing Basle II :

Risk Of Not Implementing Basle II Competitive nature of your institution
Ratings and margins
Confidence and Integrity based on best practices
Standard Setting over time

Who has begun? :

Who has begun? Most institutions have begun or some already have systems in place
Where are you?